Inventory Management, Just-In-Time, and Backflush Costing

1 Economic-Order-Quantity Decision Model Inventory management includes planning, coordinating, and controlling activities related to the flow of inventory into, through, and out of an organization. Costs associated with goods for sale: 1. Purchasing costs — the cost of goods acquired from suppliers, including incoming freight costs. Discounts for various purchase-order sizes and supplier credit terms affect purchasing costs. 2. Ordering costs — the costs of preparing and issuing purchase orders, receiving and inspecting the items included in the orders, and matching invoices received, purchase orders, and delivery records to make payments. 3. Carrying costs — the costs that arise while holding an inventory of goods for sale. Carrying costs include the opportunity cost of the investment tied up in inventory and the costs associated with storage, such as space rental, insurance, obsolescence, spoilage, and shrinkage (resulting from theft). 4. Stockout costs — the costs that result when a company runs out of a particular item for which there is customer demand – a stockout – and the company must act quickly to meet that demand or suffer the costs of not meeting it. 5. Quality costs — the costs that result when features and characteristics of a product or service are not in conformance with customer specifications. The economic order quantity (EOQ) is a decision model that, under a given set of assumptions, calculates the optimal quantity of inventory to order. The assumptions are 1. The same quantity (Q) is order at each reorder point. 2. Demand (D), ordering cost (P), and carrying costs (C) are know with certainty. 3. The purchase-order lead time (the time between placing an order and its delivery) is known. 4. Purchasing cost per unit is unaffected by the quantity ordered. 5. No stockputs occur (i.e., the costs of stockouts are so high that managers maintain adequate inventory to prevent them). 6. In deciding on EOQ, managers consider cost of quality only to the extent that these costs ordering or carrying costs. Safety stock is inventory held at all times regardless of the quantity of invenotry ordered using the EOQ model. Safety stock is used as a buffer against unexpected increases in demand, uncertainty about lead time, and unavailablity of stock from suppliers.

2 Just-in-Time Purchasing Just-in-time (JIT) purchasing is the purchase of materials (or goods) so that they are delivered just as needed for production (or sales). Companies moving toward JIT purchasing is to reduce their costs of carrying inventories (parameter C in the EOQ model). At the same time, the cost of placing a purchase order (parameter P in the model) is decreasing because: • Companies are establishing long-term purchasing aggrements that de- fine price and quality terms over an extended period. • Companies are using electronic links, such as the Internet, to place purchase orders at a cost that is estimated to be a small fraction of the cost of placing orders by telephone or by mail. • Companies are using purchase-order cards. 2 As long as purchasing personnel stay within preset total and individual-transaction dollar limits, traditional labor-intensive procurement-approval procedures are not required.

3 MRP and JIT Production Materials requirements planning (MRP) is a “push-through” system that manufactures finished goods for inventory on the basis of demand forecasts. MRP uses: 1. demand forecasts for final products; 2. a bill of materials detailing the materials, components, and subassemblies for each final product; and 3. the quantities of materials, components, and product inventories to determine the necessary outputs at each stage of production. Just-in-time (JIT) production, which is also called lean production, is a “demandpull” manufacturing system that manufactures each component in a production line as soon as, and only when, needed by the next step in the production. JIT production systems aim to simultaneously (1) meet customer demand in a timely way, (2) with high-quality products, and (3) at the lowest possible total cost. A JIT production system has these features: • Production is organized in manufacturing cells, a grouping of all the different types of equipment used to make a given product. • Workers are hired and trained to be multiskilled and capable of performing a variety of operations and tasks, including minor repairs and routine maintenance of equipment. • Defects are aggressively eliminated. Because of the tight links between workstations in the production line and the minimal inventories at each workstation, defects arising at one workstation quickly affect other workstations in the line. JIT creates an urgency for solving problems immediately and eliminating the root causes of defets as quickly as possible. • Setup time is reduced. • Suppliers are selected on the basis of their ability to deliver quality materials in a timely manner. Most companies implementing JIT production also implement JIT purchasing. The success of JIT production system hinges on the speed of information flows from customers to manufacturers to suppliers. The Enterprise Resource Planning (ERP) system comprises a single database that collects data and feeds it into software applications supporting all of a company’s business activities. The performance measures and control in a JIT production: 1. Financial performance measures, such as inventory turnover ratio, 3 which is expected to be imporved. 2. Nonfinancial performance measures of time, inventory and quality, such as: • manufacturing lead time, expected to decrease • units produced per hour, expected to increase • number of days of inventory on hand, expected to decrease • Total setup time for machine Total manufacturing time , expected to decrease • Number of units requiring rework or scarp Total number of units started and completed , expected to decrease

4 Backflush Costing Traditional normal and standard-costing systems use sequential tracking, which is a costing system in which recording of the journal entries occurs in the same order as actual purchases and progress in production.

ATTENTION ICMAP STUDENTS SOLVED CORRESPONDENCE ASSIGNMENTS OF STAGE 3-6 ARE AVAILABLE.

ATTENTION ICMAP STUDENTS SOLVED CORRESPONDENCE ASSIGNMENTS OF STAGE 3-6 ARE AVAILABLE. CONTACT 0322-3385752

My Pakistan: Branch Accounting. Theory & Practice Exercises

My Pakistan: Branch Accounting. Theory & Practice Exercises

My Pakistan: HOLDING COMPANIES

My Pakistan: HOLDING COMPANIES

COMPANY FORMATION

COMPANY FORMATION

In the formation of a public limited company having share capital, mainly four stages are involved namely:
1. Promotion
2. Incorporation
3. Capital Subscriptions, and
4. Commencement of business or trading certificate.

In the case of the formation of a private company, only the first two stages are involved, because, a private company can commence its business immediately after securing the certificate of incorporation from the Registrar of companies. But in the case of formation of a public company, having share capital, there is need for the promoters to secure from the Registrar, the certificate to commence business in addition to the certificate o~ incorporation.

1. Promotion of Company
The person or persons who undertake responsibility of bring the company into existence are called' Promoters. In other words, the work of promotion is done by a person called "Promoter" or group of persons called "Promoters". Promotion involves discovery of specific business opportunity and subsequent organisation of the factors of production. According to Haney, promotion may be defined as the process of organizing and planning the finances of a business enterprise under the corporate form in other words, the steps which are taken to persuade a number of persons to come together for the achievement of a common objective through the company form of organisation is called promotion. Promotion may be undertaken either for starting a new business or for expanding the existing concern or for forming a holding company for a merger.

Steps in Company Promotion:

The work of promotion of a company involves four stages namely;
a) Discovery of an idea and Preliminary investigation
b) Detailed investigation
c) Assembling and
d) Financing the promotion

a) Discovery of an Idea: The promoter starts out with an idea to start some business either in a new field which has not been commercially exploited or in some existing lines of manufacture or business. He makes a preliminary investigation to find out whether it is worthwhile to make a detailed investigation. He makes a rough estimate of probable revenues and expenditure.
b) Detailed Investigation: The promoter need to make a detailed investigation of his idea with the assistance of many experts like engineer, chemist, market analyst, financial expert, management consultant, etc,. On the basis of the reports of these experts, the promoters would be in a position to know the capital requirements, place of location, size of the unit, demand condition in the market, price of product, cost of production, probable return on capital, etc,. A detailed investigation will help the promoter to decide...whether the estimated income will be adequate to take care of the estimated cost of production and compension to the owner for risks and services.
c) Assembling: After a detailed investigation, if the promoter is satisfied with the practicability and profitability of the proposed concern, he starts assembling the proposition. ‘Assembling’ means getting the support and consent of some other persons to act as directors or founders, arranging for patents, a suitable site for the company! .machinery and equipment and making contracts for filling the positions.
d) Financing the Proposition: After assembling, the proposition, the promoter prepares a 'prospectus' to present to the public and to under writers to persuade them to, finance the 'proposition'. A prospectus contains complete details of the proposition and also the reports of various experts who have investigated the proposition. The promoter also takes steps to incorporate the company, and to secure the certificate to commence the business. For incorporating the company and also for obtaining the certificate to commence business, -the promoter has to full fill many legal formalities.

2. Incorporation

After taking all the preliminary steps for registration, an application along with the necessary documents, stamp duty, registration and filing fees, has to be made to Registrar for the issue of the 'certificate of incorporation. The Registrar will scrutinize the documents and if satisfied will enter the name of the company in the register .and will issue the company its birth certificate called the Certificate of Incorporation.

Steps and Formalities for Incorporation of a Company

Promoters have to take certain steps for getting the certificate of incorporation from the Registrar of Companies, on hearing from the Registrar about the availability of names for the proposed company; they have to prepare the following documents and file them with Registrar of Companies' of the state in which the registered office of company is to be situated.

A. The Memorandum of Association to which at least seven persons have subscribed, their names and each one of them has taken at least one share. In the case of a private company, then number of persons required to subscribe their names is only two.
B. The Articles of Association similarly signed except where Table' A' attached to the Companies Act 1956, has been adopted as the Company's Articles.
C. The Address of the registered office of the company.
This is to be delivered in any case within 30 days of incorporation.
D. A, list of directors with their names, addresses and occupations. The return containing the particulars of the directors should be filed within 30 days of their appointment.
E. Consent in writing of the directors to act as directors.
F. An Undertaking by the directors to take and pay for qualification shares, if any,
G. The statutory declaration by an advocate or an attorney or a chartered accountant practicing of India, who is engaged in the formation of an company or by a person named in the articles as a director manager, or secretary of the company.

At the time of filing these documents with the Registrar of Companies, necessary stamp duty, registration fees and filing fees 'are to be paid. The Registrar will examine these documents and if he is satisfied with the documents, he will enter the name of the company in the Registrar and will issue to the company its birth certificate called the "Certificate of Incorporation".

3. Capital Subscription

A private company and a public company not having any share capital can commence business immediately after obtaining the Certificate of Incorporation, but a public company having a share capital can commence business only after obtaining another certificate called the 'Certificate of Commence Business' from the Registrar of companies. Hence, a public company having a share capital has to undergo two additional stages, namely

1. The subscription stage and
2. Commencement of business stage.

In the capital subscription stage, the company has to make arrangements for obtaining the necessary capital of the company. For this purpose, immediately after getting the certificate of incorporation, the company convenes a board meeting to deal with the following business:

1. Appointment or confirmation of the appointment of the secretary if one has already been appointed by the promoters at the promotion stage.
2. Adoption of preliminary contracts.
3. Appointment of bankers, solicitors, legal advisors, brokers, auditors, etc.,
4. Adoption of draft prospectus or statement in lieu of prospectus.
5. Listing shares on the stock exchange.
6. Adoption of underwriting contracts.

Adoption of Preliminary Contracts

Before registering the company, the promoters enter into several contracts on behalf of the proposed company such as contract for the purchasing of properties and assets, or contract for purchasing existing business, if any. As these contracts were entered into by the promoters, when the company was not in existence, they become valid only when they are ratified by the company. Hence, these contracts are ratified in the first board meeting of the company.

Appointment of Bankers

According to the Companies Act, all money received by the company with the application for shares must be deposited in a scheduled bank. Hence, before issuing prospectus, the Board of Directors appoint bankers by passing a resolution to that effect. For opening an account with the bank, the secretary has to make an application to the bank along with a copy of the memorandum of association, certificate of incorporation, a certified copy of the board resolution authorizing the opening of a bank account and specimen signatures of the persons who operate the account.

4. Commencement of Business

A public company cannot commence business without obtaining from the Registrar a certificate called 'certificate to commence business'. To obtain this certificate the following conditions must be fulfilled:

1. .A prospectus or a 'statement ill lieu of prospectus' has to be filed with the Registrar of companies. A statement in lieu of prospectus has to be prepared by those companies, which do not find it necessary to issue a prospectus for the issue of their shares. The statement must include all the information which a prospectus must contain under the law; that is:
2. The number of shares allotted is not less than the minimum subscription mentioned in the prospectus (or a statement in lieu of prospectus).
3. The directors have taken up and paid for their qualification shares. The amount paid on a share by them is not less than the amount paid by other members.
4. The declaration that no money is liable to become refundable to applicants for shares for reason .of failure on the part of the company to apply for, or to obtain permission for, the shares or debentures dealt !n any recognized stock exchange.
5. A declaration by one of the directors or the secretary, or secretary in whole time to the effect that all the conditions regarding the commencement of business have been complied with.
6. An application must be made by the company to the register of companies requesting him to agent the Business Commencement Certificate

Minimum Subscription

The minimum subscription is the minimum amount, which in the opinion of the directors or signatories to the memorandum, is required to commence business. In the case of a public company the registrar will issue the certificate to commence business only when the amount raised by allotting shares, is not less than the amount equivalent to the minimum subscription mentioned in the prospectus.

The amount fixed, as 'minimum subscription' must be sufficient to provide for:
(a) Purchase price of any property bought or to be bought;
(b) Preliminary expenses and commission payable by the company;
(c) The repayment of sums borrowed to provide for the foregoing;
(d) Working capital; and
(e) Any other expenditure.

Certificate of Commence of the Business

The Registrar after receiving the declaration of compliance with the provisions of Section 149 from the secretary or one of the directors along with the required filing fees, will scrutinize the declaration and, if satisfied, will issue a certificate to commence business. From the date of the issue of this certificate, the company is entitled to commence business and also empowered 'to exercise its borrowing powers.
Further the company should get this certificate within one year of its incorporation. All ccntracts entered into between the date of incorporation and the date of commencement of business are provisional and would become binding on the company automatically only after it is entitled to commence business.

Duties of the Secretary before and after incorporation

Duties before incorporation

Before incorporation, the secretary has to assist the promoters in performing preparatory work and in fulfilling many legal formalities. He has to assist the promoters in convening and conducting meetings, .drawing up preliminary contracts and documents required for registration. At this stage, he may also take the help of specialists such as a solicitor and a chartered accountant. The duties to be performed by the secretary before incorporation are as follows:

1. To help the promoter in making a detailed, investigation of the proposed venture.
2. If necessary, on the advice of the promoters to secure the opinion of the experts in different fields on the proposed venture.
3. To help the promoters in drawing up the financial plan for the proposed venture.
4. To attend to all preliminary meetings of the promoters, keep a record of proceeding of their meetings and to help in the discussion
5. To secure the approval of the Registrar for the proposed name of the venture.
6. To help the promoters in the preparation of preliminary contracts
7. To help the promoters in the drafting and finalizing of documents such as memorandum, articles of association etc,.
8. To follow the guidelines issued by SEBI
9. To see that all requirements of the Acts as to incorporation and registration are complied with and that documents such as memorandum, articles, etc., with the required stamp duty, filing fees and registration charges are duly filed with the Registrar.
10. To collect the certificate of incorporation from the Registrar.
11. To send a notice of the registered address of the company to the Registrar within 30 days of the date of registration.

Duties of the Secretary after Incorporation:

1. To make himself thoroughly conversant with the contents of the memorandum and articles of association.
2. To prepare the draft of prospectus or statement in lieu of prospectus.
3. To call the first board meeting and get the draft prospectus, preliminary contract etc,. approved by the board.
4. To see that his own appointment is made and confirmed at the first board meeting
5. To get the necessary resolution passed for the appointment of bankers, legal advisers and other responsible officers of the company.
6. To arrange for the listing of securities of the company
7. To arrange for the opening of a bank account as per the directors of the board.
8. To secure the necessary forms and stationery and to arrange for the preparation of the common seal of the company.
9. To see that the prospectus or statement in lieu of prospectus is filed with the Registrar and to arrange for the issue of the prospectus to the public.
10. To arrange with the bankers to receive the application money from the intending investors
11. To arrange a board meeting as soon as the minimum subscription is reached and to get the necessary resolution passed for allotment of shares.
12. To arrange for the refund of application money to those who have not been allotted shares.
13. To issue letters of allotment/regret to applicants as per the decision of the board.
14. To see that all the legal requirements for commencement of business are complied with.
15. To see that a declaration is filed with the Registrar by one of the directors or the secretary himself, stating that the conditions required to be fulfilled for getting the certificate of commencement of business have been complied with
16. To collect the certificate of commencement from Registrar.

PARTNERSHIP 1

PARTNERSHIP 1

Accounting Responsibilities Of Branches

To record all transactions relating to branch like purchases , sale , expenses , receipts , payments etc.

To differentiate branch to head office or head office to branch transactions and all transactions with third party .

Either make accounts of branch independently from head office or send periodic reports to head office and after this it is the responsibilities of accountant of head office to maintain branch accounts .

If branch works as separate entity from head office and maintain his own accounts , then it is the responsibility of branch to make final account also and send it to head office .

If any branch is as distribution of sale then , if any product of branch is used in head office , then proper record will be kept in branch and its profit margin must be removed from profit and loss account . It is also true all transaction between head office and branch are not business transaction , so be careful and show profit by selling to external parties and also expenses which is paid to external parties .

My Pakistan: Business SWOT Analysis - Threats is an Opportunity

My Pakistan: Business SWOT Analysis - Threats is an Opportunity

IQRA STUDY CENTRE - Introduction to Management Accounting

IQRA STUDY CENTRE - Introduction to Management Accounting

IQRA STUDY CENTRE - PRODUCT COSTING

IQRA STUDY CENTRE - PRODUCT COSTING

My Pakistan: 7 Important Principles of Total Quality Management

My Pakistan: 7 Important Principles of Total Quality Management

My Pakistan: RISK ANALYSIS TECHNIQUES

My Pakistan: RISK ANALYSIS TECHNIQUES

MANAGEMENT ACCOUNTING: Zero Defects

What is it ?
Zero Defects, pioneered by Philip Crosby, is a business practice which aims to reduce and minimise the number of defects and errors in a process and to do things right the first time. The ultimate aim will be to reduce the level of defects to zero. However, this may not be possible and in practice and what it means is that everything possible will be done to eliminate the likelihood of errors or defects occurring. The overall effect of achieving zero defects is the maximisation of profitability.

More recently the concept of zero defects has lead to the creation and development of six sigma pioneered by Motorola and now adopted worldwide by many other organisations.

How can it be used ?
The concept of zero defects can be practically utilised in any situation to improve quality and reduce cost. However it doesn’t just happen, as the right conditions have to be established to allow this to take place. A process, system or method of working has to be established which allows for the achievement of zero defects. If this process and the associated conditions are not created then it will not be possible for anyone involved in the process to achieve the desired objective of zero defects.

In such a process it will be possible to measure the cost of none conformance in terms of wasted materials and wasted time.

Any process that is to be designed to include this concept must be clear on its customer expectations and desires. The ideal is to aim for a process and finished article that conforms to customer requirements and does not fall short of or exceed these requirements. For example, in recent years many financial organisations have made claims regarding how quickly they can process a home loan application. But what they may have failed to realise is that in spending a great deal of time and money reducing processing time they are exceeding customer requirements (even if they believe that they know them). In these cases they have exceeded the cost of conformance when it was not necessary to do so.

Advantages and Disadvantages
Advantages
Cost reduction caused by a decrease in waste. This waste could be both wasted materials and wasted time due to unnecessary rework
Cost reduction due to the fact that time is now being spent on only producing goods or services that are produced according to the requirements of consumers.
Building and delivering a finished article that conforms to consumer requirements at all times will result in increased customer satisfaction, improved customer retention and increased profitability.
Possible to measure the cost of quality
Disadvantages
A process can be over engineered by an organisation in its efforts to create zero defects. Whilst endeavouring to create a situation of zero defects increasing time and expense may be spent in an attempt to build the perfect process that delivers the perfect finished product, which in reality may not be possible. For example, a consumer requirement may be a desire to buy a motor car that is 100% reliable, never rusts and maximises fuel consumption. However, in this instance, in practice, if an organisation doesn’t have some kind of built in obsolescence it will have a more limited life.

My Pakistan: Moving toward zero inventory

My Pakistan: Moving toward zero inventory

B.COM: BUSINESS LAW: PROVISIONS REGARDING HEALTH & SAFETY

B.COM: BUSINESS LAW: PROVISIONS REGARDING HEALTH & SAFETY

My Pakistan: The Theory of Constraints (TOC)

My Pakistan: The Theory of Constraints (TOC)

EID MUBARAK TO ALL

B.COM: BUSINESS LAW: The Inspecting Staff

B.COM: BUSINESS LAW: The Inspecting Staff

B.COM: BUSINESS LAW:THE FACTORIES ACT, 1934 as amended to 1997 DEFINITIONS

B.COM: BUSINESS LAW:THE FACTORIES ACT, 1934 as amended to 1997 DEFINITIONS

B.COM: MARKET TERMINOLOGIES

B.COM: MARKET TERMINOLOGIES

My Pakistan: Evolution of Tax Culture in Pakistan

My Pakistan: Evolution of Tax Culture in Pakistan

ACTIVITY BASED COSTING

Activity Accounting with Kohler and Staubus

In the 1930s, the Comptroller of the Tennessee Valley Authority, Eric Kohler developped the concept of Activity Accounting. The Tennessee Valley Authority was engaged in flood control, navigation, hydro-electric power generation, etc. Kohler could not use a traditional managerial accounting system for these kind of operations. Instead Kohler defined activities and introduced activity accountants. An activity is (a portion of) a work carried out by a (part of) a company. For each activity Kohler created an activity account (Aiyathurai, Cooper and Sinha, 1991, PP 61-64). An activity account is an income or expense account containing transactions over which an activity supervisor exercises responsibility and control (Kohler, 1952, pp, 18-19). Thus instead of determining the costs of a product, Kohler determined the costs of an activity.
In 1971 Staubus described another activity accounting system. Staubus also created an account for every activity. On the left side of this account Staubus recorded the costs of the inputs of the activity. These inputs are the outputs from previous activities within the company and / or outputs from another entity (for instance an outside supplier). On the right hand side of the account Staubus recorded the value of the output of the activity. The outputs to another activity are measured at standard costs. If however the output is sold to a customer, the output is measured at the net realizable value (selling price minus selling costs). Staubus activity accounting culminates in a comparison of outputs, at standard cost or net realizable value, and inputs (Staubus, 1971).


Activity Cost Analysis at General Electric


In 1963 General Electric formed a team which had to study indirect costs. This team focused mainly on indirect activities in GE such as data processing, inspection, quality control etc. and determined the costs of these activities. Then they identified the causes of these activities ("key controlling parameters"). For instance a new drawing, made by the engineering department is a key controlling parameter and triggers activities such as data processing, inspection, quality control, etc. The team also collected information about the quantity or count of each key controlling parameter, such as the number of new drawings per period. Then the team estimated the total costs per unit key performance parameter, for instance the costs per 1 new drawing made by the engineering department:







With this technique GE wanted to get better control of indirect costs by controlling the activities that cause the indirect costs (Johnson, 1992, pp 131-141).


Activity Based Costing in the 1980s and 1990s


The activity based costing systems, described by Robin Cooper and Robert Kaplan in the 1980's and 1990's, has attracted much attention. These systems identifies the major activities of a facility's production process and then classifies these activities into one of the following categories:

unit-level activities;
batch-level activities;
product-sustaining level activities and;
facility-sustaining level activities.
The unit-level activities are performed each time a unit of a product is produced. The number of times unit-level activities (such as drilling holes and inspecting every part) are performed varies according to the number of units produced. The batch-level activities are performed each time a batch of goods is produced. The number of times batch-level activities (such as setting up a machine) are performed varies according to the number of batches made. The costs of these activities can be assigned to individual batches but they are fixed regardless of the number of units in the batch. Product-sustaining activities are performed as needed to support the production of each different type of product. Examples of product-sustaining activities are maintaining product specifications, performing engineering change notices and developing special testing routines. These costs can be assigned to individual products but are not proportional to the number of units or batches produced. Facility-sustaining activities support a facility's general manufacturing process. Examples of facility-sustaining activities are lighting and cleaning the facility, facility security and managing the facility.
The costs of the unit-level, batch-level and product-sustaining level activities are attributed to products based on each product's consumption of those activities. The costs of facility-sustaining activities are allocated to products arbitrarly or treated as period costs. In the example below, described by Robin Cooper (1994, pp. B1-20-B1-21);
the number of direct labor hours a product consumes is the cost driver for unit-level activities;
the number of setups a product consumes is the cost driver of batch-level activities;
and the number of parts a product consumes is the cost driver of product-sustaining level activities.





According to Robin Cooper activity based costing systems can be used to monitor how an organization's resources are consumed and helps to manage consumption and spending in a company. With activity based costing systems managers can attempt to perform its activities more efficiently, reprice poducts or alter the company's product mix (Cooper, 1994, pp. B1-9).

Balanced Scorecard

Total Quality Management

Many of the Total Quality Management (tqm) concepts originated with the work of Dr. W. Edwards Deming, the American statistician. During World War II he taught American industries how to use statistical methods to improve the quality of military products. After World War II, General MacArthur took 200 scientists and specialists, including Dr. Deming, to Japan to help rebuild the country. Many Japanese manufacturing companies adopted Dr. Deming’s philosophy. Deming’s major philosophy is that quality improvement is achieved through the statistical control of processes and the reduction in variability of these processes. Deming emphasises that management should encourage employee participation and should encourage the employees to use their understanding of the processes and how they can be improved (Munro-Faure and Munro-Faure, 1992, pp 291-292).
Dr. Joseph M. Juran broadened quality from its original statistical origin. He stressed the importance of systems thinking that begins with product designs, prototype testing, proper equipment operations, and accurate process feedback. Juran provided the move from Statistical Process Control to Total Quality Control in Japan. This included company-wide activities and education in quality control, and promotion of quality management principles. By 1968, Kaoru Ishikawa, had outlined the elements of Total Quality Control management:

quality comes first, not short-term profits
the customer comes first, not the producer
customers are the next process with no organizational barriers
decisions are based on facts and data
management is participatory and respectful of all employees
management is driven by cross-functional committees covering product planning, product design, production planning, purchasing, manufacturing, sales, and distribution (Ishikawa, 1985)

The Scorecard at Analog Devices, Inc.


In 1986 Analog Devices, Inc. (ADI), a mid-sized semiconductor company, hired Art Schneiderman as Vice President of Quality and Productivity Improvement. Schneiderman introduced goals for a series of quality measures that correspond to what he considered to be the critical success factors for ADI (Anthony and Govindarajan, 1997). As part of the five-year strategic plan of ADI, Schneiderman also developed a one page report, called the Scorecard. This scorecard showed three categories of measures: financial, new products and Quality Improvement Process:



The basic idea in creating this scorecard was to integrate financial and nonfinancial metrics into a single system in which they did not compete with one another for management airtime (Schneiderman, 2001).



The Balanced Scorecard in the 1990s


In 1990 Bob Kaplan invited Schneiderman to the Nolan-Norton study group on performance measurement. Bob Kaplan and Schneidermann presented the use of the scorecard at Analog Devices, Inc. During a second Nolan-Norton study the participants implemented scorecards within their organiations. Eric Norton, who served as the project leader and facilitator, and Bob Kaplan wrote up the experiences of the participants with the scorecard and devised a "balanced scorecard" in 1992. This balanced scorecard supplemented traditional financial measures with criteria that measured performance from the perspective of customers, internal business processes and innovation and learning. When using the balanced scorecard, companies articulate goals for each perspective and translate these goals into specific measures. An example (Kaplan and Norton, 1992):


In 1996 Kaplan and Norton argued that the balanced scorecard could be used as a strategic management system which supports four management processes (Kaplan and Norton, 1996):

Translating the Vision: Lofty statements such as "becoming the number one supplier" or "best in class" are difficult to translate into operational measures that have meaning to the people at the local level. Creating a balanced scorecard however forces management to further clarify their vision until they are able to translate the vision into a set of objectives and operational measures on the balanced scorecard, which have meaning to the people who have to realize the vision. These objectives and measures for the four perspectives, agreed upon by all executives, describe the long term drivers of succes.
Communicating and Linking: Implementing a strategy begins with communicating the strategy up and down the organization and educating those who have to execute it. The strategy must also be translated into goals and performance measures on the balanced scorecard for operating units and individuals. Rewards might be linked to these performance measures.
Business Planning: Managers set targets for the long term objectives for all four scorecard perspectives. In order to achieve these long term objectives, managers identify the strategic initiatives required and allocate the necessary resources to those initiatives. Finally, managers establish short term goals (milestones) for the measures that mark progress towards achieving the long term objectives.
Feedback and Learning: Managers formulate a strategy based on certain hypotheses about cause-and-effect relationships. Examples of hypotheses:
- a higher customer satisfaction (a measure in the customer perspective) is correlated with faster payments of invoices (a measure in the financial perspective) and faster payments result in a higher return on capital (another measure in the financial perspective) or:
- improved information systems (a measure in the internal business processes perpective) result in higher sales (measure in the financial perspective).
When a company implements the strategy it might found out that certain cause-and-effect relationships are not found over time. In that case a company should reconsider the theory underlying the unit's strategy and might even conclude that it needs a different strategy. This process of gathering feedback, testing the hypotheses on which strategy was based and making the necessary adjustments is called "strategic learning". According to Kaplan and Norton, companies should use the balanced scorecard as the center for management processes, instead of budgets (Kaplan and Norton, 2001 pp. 22-26):

Bottleneck Accounting

Bottleneck Accounting


Bottlenecks

A company usually has several activities involved in the production and selling of a product or service. For example:



In practice, bottlenecks will usually arise to constrain the amount of products the firm can deliver (Kaplan and Atkinson, pp. 62). A bottleneck is an activity that has a low production and limits total sales. If a firm wants to increase sales, it has to solve it's bottlenecks.

Traditional Variance Analysis

In a traditional variance analysis, managerial accountants analyse the differences between the sales target and actual sales. Typicaly differences between targeted sales and actual sales are analysed as below (see also Horngren and Foster, pp. 138-271).


This report indicates that the actual number of products (volume) sold was lower than the target number of products (negative volume variance) and the average sales price of products was lower than the target sales price (negative price variance). The negative volume variance and the negative price variance explain the difference between the sales target and actual sales.

This traditional variance analysis however does not point out which of the business activities were bottlenecks, which caused the negative volume variance. That is why a traditional variance analysis can't be used to solve bottlenecks in an organization.

Reporting Bottlenecks with Bottleneck Accounting


Thus, with traditional accounting techniques you just report that the actual number of products (volume) sold was lower than the target number of products (negative volume variance). With bottleneck accounting however you specify this negative volume variance by showing the bottleneck activities which caused this negative volume variance (Veltman, 2011).

An example of a bottleneck accounting report is shown below


This report indicates which activities are bottlenecks which caused a lower actual sales number: the casting activity and a decline in market demand. With bottleneck accounting you thus report bottlenecks inside the company (the casting activity) and bottlenecks outside the company (market demand).

This report also shows the magnitude of each bottleneck. The magnitude of the bottleneck is the part of targeted sales which is missed as a result of the existence of the bottleneck. In this case $ 1.114.000 was missed because of the casting bottleneck, $ 500.000 was missed because of the market demand bottleneck and another $ 180.000 was missed because of other bottlenecks.

The magnitude of the bottleneck indicates how urgent the bottleneck is. This case indicates that management should focus on the casting activity first (for instance by increasing the capacity of the casting activity). Secondly, management should focus on the market demand (improve the marketing for instance).

Thus, with bottleneck accounting you not only report which are the bottlenecks to solve, you also point out which bottlenecks are to be handled first. In that way bottleneck accounting will make your management more aware of the necessity to solve bottlenecks and of the correct order in which to eliminate them (Veltman, 2011).

Project Management Life Cycle

The Project Life Cycle refers to a logical sequence of activities to accomplish the project’s goals or objectives. Regardless of scope or complexity, any project goes through a series of stages during its life. There is first an Initiation or Birth phase, in which the outputs and critical success factors are defined, followed by a Planning phase, characterized by breaking down the project into smaller parts/tasks, an Execution phase, in which the project plan is executed, and lastly a Closure or Exit phase, that marks the completion of the project.

Project activities must be grouped into phases because by doing so, the project manager and the core team can efficiently plan and organize resources for each activity, and also objectively measure achievement of goals and justify their decisions to move ahead, correct, or terminate. It is of great importance to organize project phases into industry-specific project cycles. Why? Not only because each industry sector involves specific requirements, tasks, and procedures when it comes to projects, but also because different industry sectors have different needs for life cycle management methodology. And paying close attention to such details is the difference between doing things well and excelling as project managers.

Diverse project management tools and methodologies prevail in the different project cycle phases. Let’s take a closer look at what’s important in each one of these stages:


1) Initiation

In this first stage, the scope of the project is defined along with the approach to be taken to deliver the desired outputs. The project manager is appointed and in turn, he selects the team members based on their skills and experience. The most common tools or methodologies used in the initiation stage are Project Charter, Business Plan, Project Framework (or Overview), Business Case Justification, and Milestones Reviews.


2) Planning

The second phase should include a detailed identification and assignment of each task until the end of the project. It should also include a risk analysis and a definition of a criteria for the successful completion of each deliverable. The governance process is defined, stake holders identified and reporting frequency and channels agreed. The most common tools or methodologies used in the planning stage are Business Plan and Milestones Reviews.


3) Execution and controlling

The most important issue in this phase is to ensure project activities are properly executed and controlled. During the execution phase, the planned solution is implemented to solve the problem specified in the project's requirements. In product and system development, a design resulting in a specific set of product requirements is created. This convergence is measured by prototypes, testing, and reviews. As the execution phase progresses, groups across the organization become more deeply involved in planning for the final testing, production, and support. The most common tools or methodologies used in the execution phase are an update of Risk Analysis and Score Cards, in addition to Business Plan and Milestones Reviews.


4) Closure

In this last stage, the project manager must ensure that the project is brought to its proper completion. The closure phase is characterized by a written formal project review report containing the following components: a formal acceptance of the final product by the client, Weighted Critical Measurements (matching the initial requirements specified by the client with the final delivered product), rewarding the team, a list of lessons learned, releasing project resources, and a formal project closure notification to higher management. No special tool or methodology is needed during the closure phase.

IAS 36

IAS 36

Journal:

Definition and Explanation:

The word "journal" has been derived from the French word "jour". Jour means day. So journal means daily. Transactions are recorded daily in journal and hence it has been named so. It is a book of original entry to record chronologically (i.e. in order of date) and in detail the various transactions of a trader. It is also known Day Book because it contains the account of every day's transactions.

Characteristics of Journal:

Journal has the following features:

Journal is the first successful step of the double entry system. A transaction is recorded first of all in the journal. So the journal is called the book of original entry.

A transaction is recorded on the same day it takes place. So, journal is called Day Book.

Transactions are recorded chronologically, So, journal is called chronological book

For each transaction the names of the two concerned accounts indicating which is debited and which is credited, are clearly written in two consecutive lines. This makes ledger-posting easy. That is why journal is called "Assistant to Ledger" or "subsidiary book"

Narration is written below each entry.

The amount is written in the last two columns - debit amount in debit column and credit amount in credit column.

Advantages of Journal:

The following arte the advantages of journal:

Each transaction is recorded as soon as it takes place. So there is no possibility of any transaction being omitted from the books of account.

Since the transactions are kept recorded in journal, chronologically with narration, it can be easily ascertained when and why a transaction has taken place.

For each and every transaction which of the two concerned accounts will be debited and which account credited, are clearly written in journal. So, there is no possibility of committing any mistake in writing the ledger.

Since all the debits of transaction are recorded in journal, it is not necessary to repeat them in ledger. As a result ledger is kept tidy and brief.

Journal shows the complete story of a transaction in one entry.

Any mistake in ledger can be easily detected with the help of journal.

Objective of an Entry:

While recording transactions in journal the following two objects must be aimed at:

That each entry in the journal should be so clear that at any future time we may, without the aid of memory, perceive the exact nature of the transactions.

That each transaction should be so classified that we may easily obtain the aggregate effect of such transactions at the end of a certain period.

Narration of an Entry:

It is the remark or explanation put below each entry in the journal. The journal is a book of original entry and all possible details have to recorded in connection with each and every transaction entered there. The details are laid out in the form of a remark at the end of each journal entry, which is called narration.

Form of Journal:

Date
(1) Particulars
(2) L.F.
(3) Dr. Amount Cr. Amount


Column (1) is meant for writing the date of the transaction.
Column (2) is used for recording the names of the two accounts affected by transactions.
Column (3) is meant for noting the number of the page of the ledger on on which the particular account appears in that book.
Column (4) shows the amount to be debited to the account named.
Column (5) shows the amount to be credited to the account stated.
Rules of Journalising:

The act of recording transactions in journal is called journalising. The rules may be summarised as follows:

Use two separate lines for writing the names of the two accounts concerned in each transaction.
write the name of the debtor or account to be debited in the first line and the name of the creditor or the account to be credited in the next line
Write the name of the account to be debited close to the line starting the particulars column and that of the account to be credited at a short distance from this line.
Use "Dr" after each debit item and "To" before each credit. The term "Cr." after a credit item is unnecessary, as if one account is debtor, the other must be creditor.
To separate one entry from another a line is drawn below every entry to cover particulars column only. The line does not extend to amount column.
Example 1:

On first January, 1991 A started business with capital of $20,000 and his transactions of the month were as follows:

Jan.2 Purchased building for cash 8,000
Jan.8 Purchased goods from C 1,000
Jan.15 Sold goods for cash 500
Jan.20 Goods returned to C 100
Jan.22 Sold goods to R 400
Jan.25 R returned goods 25
Jan.31 Salaries paid for the month 200
Jan.31 Rent paid for the month 150
Solution:

Journal of A

Date Particulars L.F Debit Credit
Jan. 1 Cash Account ...Dr. 20,000
To Capital Account 20,000
(Capital introduced)


Jan 2. Building Account ...Dr. 8,000
To Cash Account 8,000
(Building purchased for cash)
Jan. 8 Purchases Account ...Dr. 1,000
To Sales Account 1,000
(Goods purchased on credit form C)
Jan. 15 Cash Account ...Dr. 500
To Sales Account 500
(Goods sold for cash)


Jan. 20 C ...Dr. 100
To purchases Returns Account 100
(Goods returned to C)


Jan. 22 R ...Dr. 400
To Sales Account 400
(Goods sold on credit)
Jan. 25 Sales returns Account ..Dr. 25
To R 25
(Goods returned by him)
Jan. 31 Salaries Account ...Dr. 200
To Cash Account 200
(Salaries paid)
Jan. 31 Rent Account ...Dr. 150
To Cash Account 150
(Rent paid in cash)
Total

30,375 30,375
Capital Account:

The proprietor's account in the business books is called "capital account". Whenever the proprietor invests money in the business, instead of giving credit to his name, capital account should be credited.

Drawings Account:

Any cash or goods taken away by the proprietor for his personal use are called his drawings and are debited to "Drawings Account". Drawings account like the capital account is personal account of the proprietor.

Casts and Carry Forwards:

In bookkeeping casting means totaling. The first page of the journal will be cast by drawing a line across the money column. The total of this page will be carried forward to the to the top of second page. The total of the second page will be carried forward to the third page and so on until the last page gives the final total.

When carrying forward the total of the one page to another, the words "carried forward" or "carried over" should be written at the bottom of the first page and words "brought forward" the top of the next page. The abbreviations c/f or c/o and b/f can also be used.

Compound Journal Entries:

When two or more transactions of the same nature take place on the same date, a compound journal entry may be made instead of making separate entries for each transaction.

Trade Discount:

No entry is passed for trade discount. The purchases or sales should be recorded at net price i.e., after deducting the trade discount from the list price.

Goods Given Away:

Sometimes goods are (a) given away as charity (b) taken by the proprietor for his private use (c) distributed free as samples. Such goods are not sales. Therefore they are not credited to sales account but are credited to purchases account because they reduce the amount of goods purchased.

Example 2:

On first April 1991 a merchant started business with a capital of $15,000 and his transactions of the month were as follows:

April 2 Purchased machinery for $7,000.
April 3 Bought furniture from S $300.
April 7 Purchased goods for cash $2,500
April 8 Sold goods to R & Sons $1,500
April 10 Bought goods from B, $1,000 and from C $2,000
April 12 Received cash from R & Sons $1,450, allowed him discount of $50.
April 15 Paid B cash $975, discount received $25.
April 16 Returned goods to C $500
April 17 Sold goods to Din Mohammad $800
April 20 Goods returned by Din Mohammad $200
April 21 Purchased from K goods of the list price of $600 subject to a 10 percent trade discount.
April 22 Paid C cash $1,500
April 25 Gave away a charity cash $50 and goods worth $30.
April 27 Distributed goods worth $200 as free samples and goods taken away by the proprietor for personal use $100
April 28 Amount withdrawn by the proprietor for private use $200
April 31 Salaries paid for the month $500
Record these transactions in the journal.

Solution:

Journal

Date Particulars L.F Debit Credit
April 1 Cash Account ...Dr. 15,000
To Capital Account 15,000
(Capital introduced)


April 2 Machinery Account 7,000
To Cash Account 7,000
(Machinery purchased)
April 3 Furniture Account 2,500
To Cash Account 2,500
(Goods purchased for cash C)
April 7 Purchases Account 3,000
To Cash Account 3,000
(Goods purchased for cash)


April 8 R & Sons 1,500
To Sales Account 1,500
(Goods sold on credit)


April 10 Purchases Account 3,000
To B 1,000
To C 2,00
(Goods purchased on credit)
April 12 Cash Account 1,450
Discount 50
To R & Sons 1,500
(Cash received and discount allowed)
April 15 B 1,000
To Cash Account 975
To Discount account 25
(Salaries paid)
April 16 C 500
To Purchases Return Account 500
(Goods returned to C)
April 17 Din Mohammad 800
To Sales Account 800
(Goods sold on credit)


April 20 Sales Returns Account 200
To Din Mohammad 200
(Goods returned by him)


April 21 Purchases Account 540
To K 540
(Goods purchased on credit)


April 22 C 1,500
To Cash Account 1,500
(Cash paid to C)


April 25 Charity Account 80
To Cash Account 50
To Purchases Account 30
(Cash and goods given in charity)


April 27 Free samples Account 200
Drawings Account 100
To Purchases Account 300
(Goods distributed free and taken by the proprietor for private use)


April 28 Drawings Account 200
To Cash 200
(Cash drawn by the proprietor)


April 31 Salaries Account 500
To Cash Account 500
(Salaries paid in cash)


Note:

(a) In actual practice even the word "Dr." is not written after the name of the account to be debited, because it is also implied.

(b) When writing the name of a personal account, it is not considered necessary to add the word "account" after the name of the person.

IQRA STUDY CENTRE - IAS 11

IQRA STUDY CENTRE - IAS 11

Accounting Principles and Accounting Equation:

Definition and Explanation:
Accounting is the language of business. Affairs of a business unit are made understood to others as well as to those who own or manage it through accounting information which has to be suitably recorded, classified, summarized and presented.

In order to make this language to convey the same meaning to all people, it is necessary that it should be based on certain uniform scientifically laid down standards. These standards are termed as accounting principles. Accounting principles may be defined as those rules of action or conduct which are adopted by the accountants universally while recording accounting transactions. In the absence of common principles there will be a chaotic situation and every accountant will have his own principles. Not only the utility of accounts will be less but these will not be comparable even in the same business. Therefore, it become essential that common principles should be followed for measuring business revenues and expenses.

Essential Features of Accounting Principles:
Accounting principles are accepted if they satisfy the following norms:

Usefulness:
A principle will be relevant only if it satisfies the needs of those who use it. The accounting principles should be able to provide useful information to its users otherwise it will not serve the purpose.

Objectivity:
A principle will be said to be objective if it is based on facts and figures. There should not be a scope for personal bias. If the principle can be influenced by the personal bias of users, it will not be objective and its usefulness will be limited.

Feasibility:
The accounting principle should be practicable. The principles should be easy to use otherwise their utility will be limited.

Accounting Concepts:

The term concepts includes those basic assumptions or conditions upon which accounting is based. The following are the important accounting concepts:

Business Entity Concept

Going Concern Concept

Money Measurement Concept

Cost Concept

Duel Aspect Concept

Accounting Period Concept

Matching Concept

Realisation / Realization Concepts

The explanation of these concepts are as follows:

Business Entity Concept:
In accounting, business is treated as separate entity from its owners. Accounts are prepare to give information about the business and not about those who own it. a distinction is made between business transactions and personal transactions. Without such a distinction, the affairs of the business will be mixed up with the private affairs of the proprietor and the true picture of the firm will not be available. The 'Business' and 'owner' are taken as two separate entities. The accountant is interested to record transactions relating to business only. The private transactions of the owner will be recorded separately and will have no bearing on the business transactions. All the transactions of the business are recorded in the books of the business from the point of view of the business as an entity and even the proprietor is treated as a creditor to the extent of his capital.

The concept of separate entity is applicable to all of business organizations. For example, in case of a sole proprietorship business or partnership business, though the sole proprietor or partners are not considered as separate entities in the eyes of law, but for accounting purposes they will be considered as separate entities. In the case of joint stock company, the business has a separate legal entity than the shareholders. The coming and going shareholders don not affect the entity of the business. Thus, the distinction between owner and the business unit has helped accounting in reporting profitability more objectively and fairly. It has also led to the development of 'responsibility accounting' which enables us to find out the profitability of even the different sub-units of the main business.

Going Concern Concept:
According to going concern concept it is assumed that the business will exist for a long time to come. Transactions are recorded in the books keeping in view the going concern aspect of the business unit. A firm is said to be going concern when there is neither the intention nor necessary to wind up its affairs. In other words, it should continue to operate at its present scale in the future. On account of this concept the fixed assets are shown in the balance sheet at a diminishing balance method i.e., going concern value. There is no need to show assets at market value because these have been purchased for use in future and earn revenues and for sale purpose. If the business is not to continue then market value will have significance. Since business is to continue, fixed assets will be shown at cost less depreciation basis. It is due to the concept that the fixed assets are depreciated on the basis of their expected life than on the basis of market value. The concept also necessitates distinction between expenditure that will render benefit over a long period and that whose benefit will be exhausted quickly, say within one year. The going concern concept also implies that existing liabilities will be paid at maturity.

Money Measurement Concept:
Accounting to records only those transactions which can be expressed in terms of money. Transactions or events which cannot be expressed in money do not find place in the books of accounts though they may be very useful for the business. For example, if a business has got a team of dedicated and trusted employees, it is definitely an asset to the business, but since their monetary measurement is not possible, they are not shown in the books of business. It should be remembered that money enables various things of diverse nature to be added up together and dealt with. The use of a building and the use of clerical service can be aggregated only through money values and not otherwise.

Cost Concept:
This concept is closely related to the going concern concept. According to this concept, an asset in ordinarily recorded in the books at the price at which it was acquired i.e., at its cost price. This cost serves the basis for the accounting of this asset during the subsequent period. The 'cost' should not be confused with 'value'. It must be remembered that as the real worth of the assets changes from time to time, it does not mean that the value of such an asset is wrongly recorded in the books. The book values of the assets as recorded do not reflect their real value. They do not signify that values noted therein are the values for which they can be sold. Though the assets are recorded in the books at cost, in course of time, they are reduced in value on account of depreciation charges. The idea that the transactions should be recorded at cost rather than at a subjective or arbitrary value is known as cost concept. With the passage of time, the market value of fixed assets like land and buildings vary greatly from their cost. These changes in the value are generally ignored by the accountants and they continue to value them in the balance sheet at historical cost. The principle of valuing the fixed assets at cost and not at market value is the underlying principle in cost concept. According to them the current values alone will fairly represent the cost to the entity. The cost principle is based on the principle of objectivity. There is no room for personal assessment in showing the figures in accounting records. If subjectivity is flowed in records the same assets will be valued at different figures by different individual. Every body will have his own views about various assets. The cost concept is helpful in making truthful records. The records becomes more reliable and comparable.

Dual Aspect Concept:
This is the basic concept of accounting. Modern accounting system is based on dual aspect concept. Dual concept may be stated as "for every debit, there is a credit". Every transaction should have two sided effect to the extent of same amount. For example, if A starts a business with a capital of $10,000. There are two aspects of the transaction. On the one hand the business has assets of $10,000 while on the other hand the business has to pay to the proprietor a sum of $10,000 which is taken as proprietor's capital. This expression can be shown in the form of following equation:
Capital (Equities) = Costs (Assets)
10,000 = 10,000


The term 'assets' denotes the resources owned by a business while the term 'equities' denotes the claims of various parties against the assets. Equities are of two types. They are owners equity and outsiders equity. Owner's equity (or capital) is the claim of the owner's against the assets of the business while outsiders equity (liabilities) is the claim of outside parties against the assets of the business. Since all assets of the business are claimed by someone (either owners or outsiders), the total of assets will be equal to total of liabilities. Thus:
Equities = Assets
OR Liabilities + Capital = Assets



Suppose if the business borrows $5000 from a bank, dual aspect of this transaction will be
Capital + Liabilities = Assets
A Loan
10,000 = 15,000


Thus the accounting Equation states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of owner's equity and outsider's liabilities. As a mater of fact the entire system of double entry accounting is based on this concept.

Accounting period concept:
According to this concept, the life of the business is divided into appropriate segments for studying the results shown by the business after each segment. Since the life of the business is considered to be indefinite (according to going concern concept) the measurement of income and studying financial position of the business according to the above concept, after a very long period would not be helpful in taking proper corrective steps at the appropriate time. It is, therefore, absolutely necessary that after each segment or time interval the businessman must stop and see, how things are going on. In accounting such a segment or time interval is called accounting period. It is usually of a year.

At the end of each accounting period and income statement/profit & loss Account and a Balance Sheet are prepared. The income statement discloses the profit or loss made by the business during the accounting period while Balance Sheet discloses the financial position of the business as on the last day of the accounting period. While preparing these statements a proper distinction has to be made between capital and revenue expenditure.

Matching concept:
The aim of business is to earn profit. In order to ascertain the profit the costs (expenses) are matched to revenue. The difference between income from sales and costs of producing the goods will be the profit. When business is taken as a going concern then it becomes necessary to evaluate the performance periodically.
A correct statement of income requires a distinction between past, present and future expenditures. A distinction between capital and revenue expenditure is also necessary. The revenues and costs of same period are matched. In other words, income made by the business during a period can be measured only when the revenue earned during a period is compared with the expenditure incurred for earning that revenue. The question when the payment was received or made is irrelevant.

Realization Concept:
This concept emphasises that profit should be considered only when realised. The question is at what stage profit should be deemed to have accrued? Whether at the time of receiving the order or at the time of execution of the order or at the time of receiving the cash? For answering this question the accounting is in conformity with the law and Recognises the principle of law i.e., the revenue is earned only when the goods are transferred. It means that profit is deemed to have accrued when property i goods passes to the buyer, viz., when sales are made.

Accounting Conventions:

The term "conventions" includes those customs or traditions which guide the accountants while preparing the accounting statements. The following are the important accounting conventions.

Convention of Disclosure

Convention of Materiality

Convention of Consistency

Convention of Conservatism

Convention of Disclosure:
The disclosure of all significant information is one of the important accounting conventions. It implies that accounts should be prepared in such a way that all material information is clearly disclosed to the reader. The term disclosure does not imply that all information that any one could desire is to be included in accounting statements. The term only implies that there is to a sufficient disclosure of information which is of material in trust to proprietors, present and potential creditors and investors. The idea behind this convention is that any body who want to study the financial statements should not be mislead. He should be able to make a free judgment. The disclosures can be in the way of foot notes. Within the body of financial statements, in the minutes of meeting of directors etc.

Convention of Materiality:
It refers to the relative importance of an item or even. According to this convention only those events or items should be recorded which have a significant bearing and insignificant things should be ignored. This is because otherwise accounting will be unnecessarily over burden with minute details. There is no formula in making a distinction between material and immaterial events. It is a matter of judgment and it is left to the accountant for taking a decision. It should be noted that an item material for one concern may be immaterial for another. Similarly, an item material in one year may not be material in the next year.

Convention of Consistency:
This convention means that accounting practices should remain uncharged from one period to another. For example, if stock is valued at cost or market price whichever is less; this principle should be followed year after year. Similarly, if depreciation is charged on fixed assets according to diminishing balance method, it should be done year after year. This is necessary for the purpose of comparison. However, consistency does not mean inflexibility. It does not forbid introduction of improved accounting techniques. If a change becomes necessary, the change and its effect should be stated clearly.

Convention of Conservatism:
This convention means a caution approach or policy of "play safe". This convention ensures that uncertainties and risks inherent in business transactions should be given a proper consideration. If there is a possibility of loss, it should be taken into account at the earliest. On the other hand, a prospect of profit should be ignored up to the time it does not materialise. On account of this reason, the accountants follow the rule 'anticipate no profit but provide for all possible losses'. On account of this convention, the inventory is valued 'at cost or market price whichever is less.' The effect of the above is that in case market price has gone down then provide for the 'anticipated loss' but if the market price has gone up then ignore the 'anticipated profits.' Similarly a provision is made for possible bad and doubtful debt out of current year's profits.

Critics point out that conservatism to an excess degree will result in the creation of secrets reserves. This will be quite contrary to the doctrine of disclosure.

Accounting Equation:

Definition and Explanation of Accounting Equation:
Dual aspect may be stated as "for every debit, there is a credit." Every transaction should have twofold effect to the extent of the same amount. This concept has resulted in accounting equation which states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of equities. In other words, for every business enterprise, the sum of the rights to the properties is equal to the sum of the properties owned. The properties of the business are called "assets". The rights to the properties are called "equities". Equities may be sub-divided into two principle types: The rights of the creditors and the rights of the owners. The equity of the creditors represents debts of the the business and are called liabilities. The equity of the owner is called capital, or proprietorship or owner's equity.

The formula know as the accounting equation, thus arrived at is as follows:

Assets = Equities

OR

Assets = Liabilities + Proprietorship


Another method of demonstrating the mathematical relationship involves a simple variation in the form of equation. Again it begins with the position that every business owns or has interest in certain assets. It also owes certain amounts to its creditors. The difference between what it owns and what it owes represents the owner's capital or proprietorship. Thus the original equation is changed into:

Assets - Liabilities = Proprietorship


Effects of Transactions on the Accounting Equation:
Each and every business transaction affects the elements of accounting equation. The effect is shown by the use of (+) or (-) placed against the elements affected. Note particularly that the equation remains in balance after each transaction. The accounting equation can be understood with the help of the following example:

Example:
Transaction 1:
Mr. Riaz commences his business with cash $50,000. This is an example of investment of asset in the business by the owner. The effect of this transaction on the accounting equation is that cash asset is increased by $50,000 and the proprietorship (Riaz's capital) is also increased by the same amount such as:

Assets = Liabilities + Proprietorship
Cash Riaz, Capital
+ 50,000 = ---- + 50,000

Note that assets and equities increased by equal amounts

Transaction 2:
Purchased furniture on cash $10,000. This transaction effected accounting equation as the increase in one new asset furniture and decreases in assets cash with the same amount. Thus

Assets = Liabilities + Proprietorship
Cash Furniture Riaz, Capital
+ 50,000 = ---- + 50,000
- 10,000 + 10,000

--------------------------------------------------------------------------------

40,000 + 10,000 = 50,000

--------------------------------------------------------------------------------


Note that this transaction has affected assets side only and no change is made in equities side of the equation.

Transaction 3:
Purchased merchandise for cash $10,000. This transaction will introduce a new element (merchandise) on the assets side and decrease the cash by $10,000.

Assets = Liabilities + Proprietorship
Cash Furniture Merchandise Riaz, Capital
+ 40,000 + 10,000 = ---- + 50,000
-10,000 -- + 10,000

--------------------------------------------------------------------------------

30,000 + 10,000 = 50,000

--------------------------------------------------------------------------------


Note that this transaction has affected assets side only and no change is made in equities side of the equation.

Transaction 4:
Purchased merchandise on account (on credit) $5,000.

Assets = Liabilities + Proprietorship
Cash Furniture Merchandise Creditors Riaz, Capital
+ 30,000 + 10,000 + 10,000 = + 50,000
+ 5,000 + 5,000

--------------------------------------------------------------------------------

30,000 +10,000 + 15,000 = + 5,000 + 50,000

--------------------------------------------------------------------------------


Note that this transaction has affected assets side and liabilities. Both the sides of equation has increased with the same amount.

Transaction 5:
Sold merchandise for cash $2,000 cost of these merchandise were $1,500.

Assets = Liabilities + Proprietorship
Cash Furniture Merchandise Creditors Riaz, Capital
+ 30,000 + 10,000 + 15,000 = + 5,000 + 50,000
+ 2,000 - 1,500 + 500 (Profit)

--------------------------------------------------------------------------------

+ 32,000 +10,000 + 13,500 = + 5,000 + 50,500

--------------------------------------------------------------------------------


Note that this transaction has affected assets side and also the proprietorship. Difference between sales price and cost price is treated as profit and has been added to capital.

Transaction 6:
Sold merchandise on credit for $4,000 costing $3,000.

Assets = Liabilities + Proprietorship
Cash Furniture Merchandise Debtors Creditors Riaz, Capital
+ 32,000 + 10,000 + 13,500 = + 5,000 + 50,500
- 3,000 + 4,000 + 1,000

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32,000 +10,000 + 10,500 + 4000 = + 5,000 + 51,500

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Note that this transaction has affected assets side and also the proprietorship. Anew element "debtors" has been introduced. Difference between sales price and cost price is treated as profit and has been added to capital.

Transaction 7:
Paid $1,000 to creditors for merchandise purchased.

Assets = Liabilities + Proprietorship
Cash Furniture Merchandise Debtors Creditors Riaz, Capital
+ 32,000 + 10,000 + 10,500 + 4,000 = + 5,000 + 51,500
- 1,000 - 1,000

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31,000 +10,000 + 10,500 + 4000 = + 4,000 + 51,500

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Transaction 8:
Received cash from a debtor $ 1,000 whom a sale on credit was made earlier. This is an example of collection from debtors. This transaction is an exchange of one asset for another. the effect is on one side of the equation, i.e., asset side. Thus:

Assets = Liabilities + Proprietorship
Cash Furniture Merchandise Debtors Creditors Riaz, Capital
+ 31,000 + 10,000 + 10,500 + 4,000 = + 4,000 + 51,500
+ 1,000 - 1,000

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32,000 +10,000 + 10,500 + 3000 = + 4,000 + 51,500

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Transaction 9:
Paid salaries $1,000 in cash. This transaction affected the equation by decrease in a cash asset and decrease in proprietorship (i.e., capital). Thus:

Assets = Liabilities + Proprietorship
Cash Furniture Merchandise Debtors Creditors Riaz, Capital
+ 32,000 + 10,000 + 10,500 + 4,000 = + 4,000 + 51,500
- 1,000 - 1,000

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31,000 +10,000 + 10,500 + 3000 = + 4,000 + 50,500

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Effects of all the transactions explained above are presented in the following table:

Assets = Liabilities + Proprietorship
Cash + Furniture + Merchandise + Debtors Creditors + Riaz, Capital
1 + 50,000 +50,000

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50,000 = + 50,000
2 - 10,000 + 10,000

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40,000 10,000 = + 50,000
3 - 10,000 + 10,000

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30,000 10,000 10,000 = + 50,000
4 + 5,000 + 5,000

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30,000 10,000 15,000 = 5,000 + 50,000
5 + 2,000 - 1,500 + 500 (Profit)

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32,000 10,000 13,500 = 5,000 + 50,500
6 - 3,000 + 4,000 + 1,000 (Profit)

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32,000 10,000 10,500 4,000 = 5,000 + 51,500
7 - 1,000 - 1,000

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31,000 10,000 10,500 4,000 = 4,000 + 51,500
8 +1,000 1,000

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32,000 + 10,000 + 10,500 + 3,000 4,000 + 51,500
9 1,000 1,000

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31,000 10,000 10,500 3,000 = 4,000 + 50,500

The elements of the equation of Mr. Riaz that is,

Cash + Furniture + Merchandise + Debtors = Creditors + Capital
31,000 + 10,000 + 10,500 + 3,000 = 4,000 + 50,500

This may also be stated in vertical form as shown below:

EQUITIES ASSETS
Creditors $4,000 Cash $31,000
Capital $50,500 Debtors 3,000
Merchandise 10,500
Furniture 10,000

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$54,500 $54,500

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The presentation of the effects of transactions in tabular form is only a device which helps beginners to understand the analysis of different types of transactions. It is not practically feasible to record the effects of transactions in this form. The increases and decreases in the various elements are recorded in the journal in a special technical form.